The growth of smart-beta exchange-traded funds in Asia has outpaced that of the overall exchange-traded fund (ETF) market this year, as large institutional investors increasingly adopt sophisticated strategies being adopted, say local fund executives.

Dividend-weighted ETFs are currently the most popular category, but asset managers say they are launching more complex products due to asset owner demand, including multi-factor ETFs and factor-timing products. 

When smart beta took off in Asia last year, low-volatility ETFs—which favour stocks with more stable prices—were the main drivers of volume. Now smart-beta offerings are becoming increasingly sophisticated, such as by infusing active management elements into an index.

Smart beta strategies are ways of identifying a portfolio using means other than market capitalisation, often via a set of traditional factors, such as momentum, growth, high-dividend, value and low volatility.

Large Asian institutions are well above trend in their take-up of factor-based strategies, according to BlackRock, the biggest ETF provider. Asian institutions account for around 20% of the firm’s total assets under management (AUM) in its ‘enhanced’ factor strategies (active and systematic applications of factor investing). That compares to the 7% of its total AUM that BlackRock reports as coming from Asia Pacific.

The most popular factor strategy targets high-dividend-paying stocks, according to industry data (see graph below), offering institutional investors a higher income tilt within their portfolios.

Equity smart-beta ETF flows in 2017 by type ($ billions)

  Sep 2017 flows 2017 YTD flows Current assets
Dividend 0.8 11.4 183.2
Multi-factor 1.5 9.0 67.8
Low-volatility 0.4 2.2 52.4
Equal-weight -0.4 2.4 47.2
Single-exposure 0.7 6.4 37.5
TOTAL 3.0 31.3 388.0
 

Source: BlackRock, Bloomberg, Strategic Insight

Ben Garland, senior investment strategist in BlackRock’s factor-based strategy group, told AsianInvestor that Asian official institutions are at the forefront of factor adoption, actively using a top-down factor approach to risk allocation and portfolio construction.

Investors want to know what factors they are exposed to, said Hong Kong-based Garland. “These large institutions are deploying factor analysis on their portfolios to see how the approach contributes to their overall risk and returns, thereby allowing them to construct more robust and efficient portfolios."

Avoiding excessive fees

Australia’s A$133 billion ($104 billion) Future Fund is one investor building an alternative beta portfolio. Chief executive David Neal said the sovereign wealth fund has been managing the active component very tightly to avoid paying excessive fees for beta or alternative beta that can be obtained much more cheaply.

He told AsianInvestor the fund should understand and “own” the exposure to different factors. “We should understand what they are, how much we’ve got, how they are configured and that we can build that technology ourselves, though we would continue to execute it through external managers,” Neal added.

Sunny Leung, head of ETF, indexing and smart beta sales at Amundi in Hong Kong, told AsianInvestor that an insurance company client recently asked the firm to analyse its equity portfolio using a factor framework. The objective was to identify the main factor exposures of their portfolio and to analyse the weightings for the individual factors.

The analysis showed a diversification across factors, but with underweighting of value and volatility and slight overweighting of momentum. Their under-exposures to value resulted in the portfolio underperforming at the end of 2016.

"They wanted a solution to correct this bias without affecting the overall risk factor profile of their portfolio," said Leung. "By implementing a dynamic multi-factor allocation process, they increased their exposure to the value factor and better balanced their exposure to individual factors."

The largest market for smart-beta ETFs in Asia is Japan, but that is heavily skewed by the central bank’s buying ¥6 trillion ($53 billion) of ETFs annually as part of its stimulus programme, leaving it with a 70% market share of the products in the country. ETFs tracking the JPX-Nikkei Index 400, a smart-beta benchmark that targets quality stocks, are eligible under the Bank of Japan’s purchase programme.

Rising demand for passive investing in general has led more active fund houses such as JP Morgan Asset Management to look to sell smart beta and hedge fund-type alternative products to regional clients rather than traditional index-based ETFs. One advantage of doing so is that smart beta products typically charge slightly higher management fees than index-focused passive funds—often around 15 basis points (bp) or more as opposed to less than 10bp.

However, despite the trend for institutions to re-assess their active exposures, not all industry observers are convinced that smart beta will become as widely used as some believe.

Paul Price, global head of distribution at Morgan Stanley Investment Management, told AsianInvestor: “A lot of research is being done on smart beta by sovereign wealth funds, but I’m not convinced money is chasing it quite as hard as some are suggesting. I’m not sure that in the long term it will be quite as significant as people are talking about.”

Joe Marsh contributed to this article

AsianInvestor will be conducting the ‘Finding The Way Through The Smart Beta Maze’ webinar on November 15th at 4pm Hong Kong/Singapore time, exploring the latest developments in factor investing among the region’s institutional investors. To register for free for this webinar, please click here.